JakilaTheHun (99.90)

Four Mortgage REITs with Insider Buying

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Mortgage REITs have dropped over the past week based on fears surrounding the debt ceiling issue. Yet, perhaps the exact opposite result should have occurred. While people will initially view the debt deal as a “bullish sign," in fact, it’s just the opposite. It could very well ignite the next recession, as more money is pulled from the economy. Couple this with continued problems in the eurozone and a potential East Asian crisis, and there are a lot of reasons to be cautious.

I expect inflation and interest rates to stay subdued for the next 12-24 months, at the very least. There are too many hurdles in the way of a more vibrant recovery, and a U.S. austerity package will add another one. While I continue to hold a few bullish bets, including the homebuilders, I have certainly veered more toward a hedged position over the past five months and I’ve made an effort to increase my position in high-dividend paying stocks, with an emphasis on mortgage REITs (“mREITs”) and utilities.

Here are four mortgage REITs that I believe represent good value based on the thesis laid out above:

This is a value-based mREIT that invests in both agency and non-agency securities. It is managed by Pine River Capital Management and it has some hedge fund-like characteristics. What attracts me to Two Harbors is the quality of its management team (or I should say, Pine River’s team), the value orientation of the company, and the heavy insider buying. With a price-to-book ratio right around 1, it's priced fairly, and the dividend is strong at 16.3%.

If you want to read more about Two Harbors, check out Marc Gerstein’s excellent article back in March. While this is hardly a low-risk investment, I believe in a weak market, it would be an attractive holding.

One risk to consider here is that this is a relatively new mREIT without a long-term track record. Also, while Two Harbors does invest in a lot of non-agency securities, it has moved more toward fixed-rate agency holdings over the past year, making it more vulnerable to interest rate movements.

(2) MFA Financial (MFA) - P/B ratio = 0.92, 13.4% yield, under $8.25

MFA Financial is a mortgage REIT that invests in both agency and non-agency securities. This is another mREIT with a considerable amount of insider buying. Part of my strategy on mREITs is to diversify my holdings, with some that have high agency holdings, some others with substantial non-agency holdings, and some that fit somewhere in the middle. I’ve looked for high insider buying, strong management track records, and attractive pricing. MFA is one that has caught my eye for all of these factors. Unlike the neophyte TWO, MFA also has a solid long-term track record

To read more about this REIT, I would recommend Parsimony Investment Research’s article on MFA in June.

Continuing with my theme of mREITs with high levels of insider buying, we come to Dynex (DX) and Hatteras Financial (HTS). Both HTS and DX invest in agency MBS. The primary risk factor for these REITs is that interest rates could move up, making the yield on their securities less attractive, comparatively speaking. However, some of the mREITs are better hedged against rising interest rates than many tend to believe. Parisomony’s recent article on Hatteras gets into this very issue. Hatteras is actually very well hedged against rising interest rates, since they invest exclusively in adjustable rate mortgages. Likewise, Dynex is better hedged against rising rates than many others. I would recommend George Spritzer’s article on DX for those who want to learn more.

Conclusions and Risks

There are substantial risks with investing in mortgage REITs. For example, in the rising rate environment of 2005, many mREITs had horrendous performances. Given the very low rates in the market right now, this could be a bad omen for the mREITs, but my belief is that the market is already pricing this in. Moreover, many will be surprised at how stubbornly low the rates will become. Not only is “hyperinflation” not likely, there's a significant possibility that we’ll stay in an environment of subdued inflation, or even minor deflation. This could make mREITs an attractive investment class.

For this reason, I see mREITs as a vital class of securities to own. Betting the farm on these securities would be folly, but they could definitely help hedge one’s portfolio in a down or sideways market environment if used properly.

Other Resources

If you want to learn more about mREITs, I’d recommend following the authors below on Seeking Alpha:

I saw this on SA and was about to accuse you of plagiarizing! (but you came clean in your comment)

Great article. I have owned shares of MFA for a couple years now and plan to add more whenever I have some extra cash. I also like what I see in TWO. I need to do more research on the other 2 but they look promising as well.

H.J. Thanks for the comments on my debt blog. I've also been looking at REITs after a few cropped up on my radar due to the debt issue. You added one to my list that I didn't have yet, DX. I didn't realize there were that many out there. It's interesting and I appreciate your notes, on the variance. Some are leveraged for ARMs, some are hedged, some are new and some are older. I've had AGNC for over a year now. I put HTS on my CAPS list over two years ago. It's still in the red even after the dividend reinvestment, but I was certain that it was a poor CAPs play when weighed against the S&P in the short run. It should be green in six more months or less.

I think some of them can be good CAPs plays sooner as I expect the S&P to flatline more or less, and I caught a few of them near their depressed states. I'm researching them and digging in. I appreciate your list and links!

I really think it's the point in the recovery, or lack of recovery where these plays are worth some research.